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expense throughout timeGross profit percentage– sales, less COGS, divided by net sales-(Sales – COGS) (Net Sales)Net Income Percentage– (return on sales) measures the percentageof sales left after subtracting COGS, all operating expenses, interest & taxes-(net income) (net sales)Example:oWhat the percentages will tell you (if profitability is dropping)Sales % increase, but net income % drops furtherGross profit percentage decreases from year 1 year 2Net income percentage decreases from year 1 year 2oProfitable, but trend is not goodPast performance may not be sustained in the futureQuestion 3: Where Is the Business Getting Its Money and Can It Pay Its DebtObligations?
oFinancing decision– how a business acquires money, debt or equity, to acquire assetsDebt / equity = both have a costoReviewing LiabilitiesAmount, types, and changes in debt a business owesNotes interest rate charged on debt, when debt is due, features of debt (covenants)Debt Covenants– conditions, stated in the debt contract, that specify the requirements agreed to by the lender and borrower-Ex: Collateral-Collateral– assets pledged by a borrower to guarantee the payment of a liabilityoReviewing Stockholders’ EquityAmount, types, and changes in stockholders’ equityNotes what is happening with stockholders’ equity-Common stock, preferred stock, retained earnings, dividendsStatement of retained earnings-How retained earnings changed from BEG to END of periodoGoal = obtain money at lowest possible costCan’t have too much debt-But debt is cheaper than stockholders’ equityVertical analysis-How much debt a business has relative to stockholders’ equityHorizontal analysis-How a business is changing the blend of liabilities / stockholders’ equity over timeoRatios
Debt ratio– measures a business’s ability to pay liabilities-(Total Liabilities) (Total Assets)Interest coverage ratio– measures the number of times that operating income can cover interest expense (times interest earned ratio)-Operating Income (EBIT) Interest ExpenseExample:oGiven:Debt Ratio = 47.1%Interest Coverage Ratio = 2.5oCan the business pay its debt? YesStrong operating cash flowSufficient operating income to cover interest expenseoCompany is well financedRisk of defaulting on debts = lowIt is paying its debtsQuestion 4: How Is the Business Investing Its Money and Is It Using Its Assets Efficiently?oInvesting Decision– how a business uses money to acquire moneyGoal = to create operating income that adequately rewards lenders / owners for use of their moneyoAnalyzing AssetsTypes of assets invested intoHow asset investments change over timeBalance sheet amount, types of, changes in assets a business ownsNotes insights (ex: depreciation assumptions)oHow Assets Produce IncomeProductivity of each asset